Lessons from a volatile market

WeekendInvestor

LOS ANGELES (CBS.MW) -- Any market drop is painful, but investors can take the opportunity to learn from it.

"Successful investing requires discipline, having a balanced investment program and it should be long-term in nature." Jack Brod Vanguard Group

"One of the key lessons is that equity markets will have periodic corrections. You have to be prepared for them," said Bruce Alston, money manager for Value Line Asset Management, an investment services firm.

For investors who lost money a week ago on technology highfliers that painfully crashed to earth, or at least couldn't sleep at night because of the volatility, it's back-to-basics time.

"Successful investing requires discipline, having a balanced investment program and it should be long-term in nature," said Jack Brod, a principal at The Vanguard Group and head of the mutual fund company's asset management and trust services division, which handles $2.8 billion.

Alston and Brod share these timeless lessons that may have been forgotten in the tech euphoria:

Don't put money you can't afford to lose into stocks. Funds invested in stocks should be money you won't need for five years or more.

Diversification is critical. Make sure you have money in stocks, bonds and cash. "You'll have reduced risk with a balanced portfolio," Brod said. "It's important to diversify among market sectors and avoid chasing investments with a recent, hot performance. More often than not, it will lead to disastrous results. In a euphoric market, investors tend to forget the risks inherent in investing." From April 14, 1999, to exactly a year later, Brod said Nasdaq stocks had a total return of 32.8 percent. But from March 9 to April 14, 2000, the Nasdaq dropped 34.2 percent. How investors should allocate a portfolio depends on the time horizon, investment objectives, risk tolerance and overall investment experience, Brod said. But generally, people with high tolerance for risk and a longer time horizon should put 65 to 100 percent of their investment money into stocks, he said. Of course, that assumes cash covering at least three months of living costs have been set aside for emergencies. Investors with a moderate tolerance should have half in stocks and the rest in bonds. Those with low tolerance should stick to 35 percent in stocks and 65 percent in bonds. Within stocks, Brod recommends putting 70 percent in large-caps and the rest in smaller companies. These should further be diversified into domestic, international, growth and value stocks. That said, Brod points out that investors who feel uncomfortable about putting money in stocks because of market risk should consider the other risk often ignored: Inflation. History shows that stocks bring the best returns over time. By putting money in certificates of deposit and other low-yielding accounts, people risk not having enough to retire or meet other investment goals. "You have to manage all your risks," Brod said.

If you want to change your investment allocation, do so gradually, Alston said. Resist the temptation to make large-scale changes just because one part of your investment is heading south. Performance among different market sectors tend to rotate.

Get rich slow. Set a long-term strategy. "People tend to look for unrealistic short-term returns," Brod said. Avoid letting short-term results and news affect your portfolio too much. Stay away from knee-jerk reactions to market news. It's difficult, if not impossible, to always correctly time the market. Momentum investing may be popular, but it's more a type of gambling than sound investing, Brod said. Better to avoid it.

Buy quality companies, Alston said. The companies that will hold up best in a market downturn are those with good fundamentals.

Continue investing regularly, through an automatic, or regular, investment plan. That way, you'll average out the cost of investing. It's not always wise to buy on a dip, Brod said, because you don't know whether the market will head lower or not. It's better to hedge your bets by putting in a little bit of money at a time.

Don't always chase after the latest hot stock. By the time the company is all over the headlines as a highflier, chances are the stock is fully valued. You want to get in early, not late, Alston said.

Trading on margin, or borrowed money, is treacherous. Avoid it.

Don't forget the tax consequences of selling, Alston said.

Readers share investing tips: Trix Abriol of Canoga Park, Calif. is sleeping well despite the market's volatility. Even though her technology stocks got hammered like everyone else's a week ago, she didn't worry because she owned quality, profitable companies and bought them at a good price. Her strategy: Research a stock thoroughly before buying it. Don't just buy at any price, but wait for an expensive stock to trade within a more reasonable price range before jumping in. She avoids stocks with triple-digit price-to-earnings ratios. Abriol also makes sure she always has a cash reserve to buy stocks. Got a good tip that only experience taught you? Share it with other investors. Email Weekend Investor

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